Where to put my money (debts and savings questions)
August 8, 2015 4:37 AM   Subscribe

I'm coming into some money. How should I allocate it? Exciting debts inside.

I'm coming into $29k from a small trust soon. Let me give you the specifics of my situation and debts and ask if you can help me figure out how to best allocate it.

Every single penny of my paycheck is being spent at the moment. I live in NYC, so my rent is about half of my take-home pay, the rest is going toward basic city-living costs and paying down debt. Please assume that I am living as frugally as possible and have no left-over at the moment to put into savings/retirement/investing. I am not asking for ways to save, I am asking for ways responsibly allocate the money I'm coming into. I hope to get a small raise or bonus this year, but I am not factoring that in at all.

$2.5k in regular [low/no-yield] savings account.
I have no retirement/401k/IRA accounts.

Student loan: $40k, all federal, at 5.8%
Credit card #1: $3k balance at 14.9%
Credit card #2: $2k balance at 0% for the next 14 months

My current [partial] plan:
Put $15k toward student loan debt.
Pay off all of the $3k on credit card #1.
I plan on paying off credit card number #2 in the given 0% window.
I'm allotting $2k for upcoming travel that I have planned.

My question:
Considering I am living paycheck to paycheck and have no substantial emergency savings, where is the best place to put the remaining $9k?

Currently my company offers a 401(k) to which I am not contributing. Starting May of 2016 they will match 1/2 up to 6% (i.e. if I contribute 6%, they will contribute 3%, which is the max). It was suggested to me that I start contributing from my paycheck to my 401(k) and pay myself back from the chunk of cash since I can't really afford the deduction from my paycheck at the moment. Is this an okay idea?

I know I need to keep a good bit of this money relatively liquid because I have no emergency savings, but what's the best way to do this? I've also looked into Roth IRAs and money market savings accounts, but I'm really just not sure what the best course of action is.

I am single, child-less, early thirties living (with a roommate) and working in New York. Previous to my current position, I've always been some combo of freelance and under the table hence my lack of previous financial planning.

Any advice welcome. Thanks!
posted by anonymous to Work & Money (16 answers total) 8 users marked this as a favorite
If the credit card is one of those deals where it's 0% unless you don't pay if off, and if you don't there's suddenly massive fees/interest, I would pay it off too and then apply the payment amount you would have made to retirement savings at work as a minimum. That way you get some matching and savings earlier in your career (yay magic of compound interest!) Also, if that becomes an amount your regular budget can absorb you can just keep going with it.
posted by warriorqueen at 4:51 AM on August 8, 2015 [2 favorites]

I think your plan is right in that you're prioritizing paying off high interest debt - make sure that you continue to manage credit in a way such that you never again carry a balance on your credit card.

Typically a recommended first step to investing (after debt considerations are taken care of) is contributing to maximize employer contribution, so the idea of paying yourself back to make up for the deduction isn't a bad idea.

Given that you're living paycheck to paycheck, you do want to keep an emergency fund - depending on who you ask, experts recommend anywhere from 3-6 month's expenses, liquid. You don't need to make this complicated - a savings account is completely okay, but you can also look into things like short term CDs that could potentially net you a tiny bit more interest. The idea is that if you have an unexpected expense that comes up (or you lose your job) you have enough money liquid that you won't blow a hole in the rest of your budget for the month, so that's where the emergency fund comes in - you want that available without having to dip into your retirement savings.
posted by Karaage at 5:51 AM on August 8, 2015 [1 favorite]

Cards, emergency fund, then the student loans.

Personally I think one year living expenses is a good emergency fund.
posted by JPD at 5:59 AM on August 8, 2015 [5 favorites]

I think your plan sounds fine.

Regarding your 401K, start as soon as you can, and definitely contribute enough to claim all of the match, once that starts, otherwise you’re leaving money on the table. Start a Roth as soon as you can, and contribute as much as you’re comfortable with. Your mind frame here should be that you will not touch these funds until you retire.

For your 401K and Roth investment choices, you want broad diversification at the lowest fees possible. For those who don’t want to figure all that out, a “target date” fund can be ideal, provided (again) the fees are low. (My rule of thumb is that admin fees must be less than 1%, and preferably ½% or lower.)

If you wanted to build yourself a little more wiggle room—and I’m not saying you should—you might consider reducing your student loan payment to $10K in order to have an additional $5k to add to your emergency funds. I say this because a financial cushion of about 6 months’ living expenses should be a high priority. It provides incredible peace of mind should your employment situation go south, for example, which to me is a good trade-off on the $5K you’ll still be paying 6% on.

As to parking the cash, I use both savings and money market accounts, but there’s really not much difference, interest rates being so low. I don’t bother with CDs. When my goal is liquidity, I have no interest in tying up funds for a pittance in return.

If you haven’t already, be sure to plan for taxes you may owe on the inheritance.

For the record, I had no savings when I was in my 30s. I’m now 63 and retired, thanks to frugal living, which is to say, always making sure I was earning more than I was spending, even when that meant dining on Kraft Dinner.

One final note: a quick and easy “financial check-up” is to calculate your net worth every six months or so. Add up your assets (e.g. cash and investments) and subtract your liabilities (e.g. loans). That result should increase over time. If it’s not, you need to take action.

Hope this helps. Best wishes!
posted by Short Attention Sp at 6:06 AM on August 8, 2015

I would actually pay off the two credit cards first. True, you're at an introductory 0% rate on one card, but you have to pay it every month. If you pay off both cards, you remove two monthly payments -- looks like the minimum payments on those would be around $200 a month, or closer to $250 if you're paying off the second card in 14 months? So that frees up a little breathing room in your monthly budget.

Hopefully you can then put the money you're not putting towards the cards towards the 401(k) match -- it's an excellent way to help build retirement savings. It looks like 6% of your salary would be ~$115 a paycheck, but if you have a traditional 401(k), that's taken out pre-tax and you'll see a smaller impact than that in your actual check. If you can't do that, start with whatever you can do, even if it's just 1%.

Short Attention Sp makes an excellent point about taxes, so make sure you take that into account. If this money will be subject to taxes, you could consider parking $5,500 of it in a traditional IRA, which would cut down on your tax burden a little. However, note that you then won't be able to withdraw that money without paying taxes and a penalty (penalty will be waived when you're 59 1/2 or for certain types of expenses).

Once you're through those steps, I would then seriously consider keeping any remaining money liquid and using it as an emergency fund and buffer fund. Your monthly student loan payment isn't going anywhere if you pay $15K, and if you live in NYC, you have high expenses each month. (Unless you have more than one student loan? If you're removing a monthly payment with $15K, it might be worth it).

I typically try to keep 1-2 months rent in a savings account at my regular bank, and 6 months expenses (rent, regular bills, food) in an online savings account where the interest is a bit higher.

You can also put that money in a Roth IRA, which is just a type of account where you can park post-tax money and not have to pay taxes on your earnings. The money in a Roth can go into a money market, bond fund, or even a regular savings account. You can withdraw your contributions (but not your earnings) at any time without penalty, which is why a Roth is appropriate for money you may need in an emergency.

Note that you can contribute only $5,500 combined year year to the Roth, which is post-tax, and/or traditional IRA, which is pre-tax. So if you contribute the full $5,500 to a traditional IRA to cut the taxes due, the Roth won't be an option that year (and vice versa).

Standard rule for what to invest in: If you absolutely need the money to be there when you need it, keep it in a low-risk investment, which means a money market or better yet, a regular savings account insured by FDIC or NCUA (ideally a high-interest savings account).
posted by pie ninja at 6:35 AM on August 8, 2015

I think people have given you great tips! Here's another possibility to consider; the numbers are just suggested so you could play with them as you see fit.

- $5K to completely pay off both credit cards

- $10K for an emergency fund (perhaps in a money market account?)

- $3K for a "life happens" fund (You can read about the term on this page)

- $5K for retirement through your 401(k) (A traditional or Roth IRA is a good idea for later or now as an alternative, too.)

- $5K for your student loans

- $500 for a need or want of yours (tickets to visit family, new couch, etc.)

- $500 for fun (so you don't feel deprived while being so practical)
posted by smorgasbord at 7:22 AM on August 8, 2015

I am not asking for ways to save, I am asking for ways responsibly allocate the money I'm coming into.
That is exactly what you're asking! You may not be looking for ways to reallocate your current income but you are certainly looking for ways to "save" money.

MoonOrb has it with the idea of retirement savings. I've built a model below that assumes your employer matches IRA contributions. The point MoonOrb makes is great, that retirement contributions act as part of your total cash savings. There may be a penalty for withdrawal, but they are still liquid.

What the model does below is moves your financial outlook to a net position way of thinking – that is rather than separate everything into individual buckets, it lumps it all together.

What I see is that you can:

1) Pay off the credit cards. That avoids interest, and also frees up the balances for emergencies.

2) Create a retirement account that has two benefits: 1) employer matching, and 2) interest payments. That step begins defraying the interest cost from your student loan, and gives you a 3% salary increase from the employer contribution.

3) Existing savings and travel basically cancel out.

4) Where you end up on the other side is having $22k in cash, with $5500 cash-equivelents (IRA), for a total position of $27,500.

5) That $27,500 gives you 71 months of debt coverage, assuming the interest payment and principle payment are equal.

I would advise that you keep that cash in the bank, and focus on increasing your salary. You can either draw on the cash for lifestyle reasons as you need to, or it will be available if you want to change jobs to a higher-paying role.

In terms of the student debt, debt is designed to remain at a constant rate, while the value of investment – you and your salary – increase. Thus, consider your current debt to be serviceable, and focus on increasing your salary. Then make increased debt repayments from your salary. It's not bad having debt as long as it's well-managed.

Another way to think about keeping the cash intact, rather than paying down the debt, is that you are now paying part of the interest to have liquid cash available. Cash is a short-term asset – you can use it right now – while the debt is a long-term liability. The purpose of student debt is to be repaid over time, hence, repaying it now may not make the most sense for you.

There's the general sense to reduce interest payments as much as possible, for interest is "wasted" money. In reality, it's very much not, if you look at your personal balance sheet from a position point of view.

If you believe that you are going to make more money in the future, it makes sense to maintain your current level of debt payments, and have a strong cash position. If you believe that you are going to make less money in the future, it may make sense increasing your debt repayment, but then again, it may not.

If you take a position point of view, paying off your student loan would reduce your debt payment in half. So you can either pay $368 a month and have $27k in cash, or you can pay $180 a month, and have $5k in cash. Is it worth the marginal savings now not to have the cash available? Debt is part of your life, but it's not your whole life. If you expect that by having $22k extra in the bank now, that you will increase your salary by more than $200 a month in the long term, it may make sense to keep the cash intact. Keep in mind, you have already raised your salary by $125 a month by taking the employer contribution.

There's only two ways to increase your position – save more of your current salary by decreasing your expenses, or increase your current salary. Either way, ending the year going from month-to-month to having 71 months debt coverage, or 1 year living expense cover, gives you a lot more flexibility.

By using retirement savings correctly, you immediately get a 3% salary increase, create a long-term savings account, and begin earning interest/yield.


Step 1: Cancel-out high-cost debt
+29000 money in
-3000 credit card #1
-2000 credit card #2
+2500 existing savings
=26500 cash position

Step 2: Set-up retirement account
+50000 total income
-1500 employee contribution to IRA
=48500 adjusted income

Retirement plan:
+1500 employee contribution to IRA
+1500 employeer contribution IRA

Total earnings
+48500 adjusted income
+3000 total IRA contributions
=51500 total earnings

Step 3: Take trip
+26500 cash position
-2000 expenses
=24500 cash position

Step 4: Contribute to IRA
+24500 cash position
-2500 employee contribution to IRA
=22000 cash position

Step 5: Cash position
+22000 cash position
+5500 IRA position
=27500 current position

In Case Of Emergency Break Out Plastic
+27500 current position
+5000 short-term debt facilities
=32500 total cash available

Step 6: Overall position
+27500 current position
-40000 student loans
-1500 salary shortfall
=-14000 overall position

Step 7: Compare to position
Previous position:
-3000 credit card #1
-2000 credit card #2
+2500 existing savings
-40000 student loan
-2000 expenses
=-44500 previous position

New position:
-14000 overall position

Change in position:
+30500 position increase

Step 8: What about the student loan?
-40000 principle
5.8% interest
-2,320 annual interest
-193.33 monthly interest
-193.33 principle payment

-386.67 total payment
+27500 current position (cash + IRA; not including credit cards)
71 months payment cover
posted by nickrussell at 8:52 AM on August 8, 2015 [1 favorite]

How stressful is it for you to live paycheck to paycheck?
Perhaps removing the monthly payments by paying off the cards will give you a large benefit in quality of life.
posted by fullerine at 8:53 AM on August 8, 2015

Years ago, I read that a good rule of thumb when you get a large windfall is to spend a third on the past (pay down debt), a third on the present, and a third on the future (save/invest). I don't think I could bring myself to blow a third of it, but I do think you should think a bit about spending more than $2k of it on yourself currently. Look around and see if there is something in your life in dire need of a little love. Is your professional wardrobe really threadbare? Would you cook more and spend less on meals eaten out if you had a better kitchen set up (nicer pots and pans, maybe an island on wheels or certain small appliances)? Etc.

In my experience, when you live paycheck to paycheck and then come into money, some of those needs will syphon the money away anyway. Rather than put $15k towards student loans, it would be better to pay off both credit cards, put at least $4k towards the student loans, and then consider allocating a bit of this money for spending in the here and now. Otherwise, the odds are good that something will come up, you will spend the money anyway and you will feel wracked with guilt but also try to console yourself or justify it based on having had a windfall. Don't do that to yourself. Admit upfront that a bit of this money should be spent on making your life better in the here and now and budget for it. The money will get managed better if you account for that upfront.

If you do not do that, the odds are good that you will not manage to save/invest anywhere near as much as you are planning to. After giving $15k to pay down student loans, you cannot get that back. You can't say "Just kidding!" And credit card debt tends towards painfully high interest. So the easiest answer becomes spend the cash left that you had earmarked for savings.

So if you want to actually put anything into savings, consider reallocating some of what you have earmarked for debts. You don't need to bump up the "spend it in the present" portion to an entire third, but it is currently below 10% of the amount. That probably does not work that well.
posted by Michele in California at 10:17 AM on August 8, 2015

I know this is not 100% on topic, but when I look at your debt load the credit cards call out as the #1 thing that needs to go (and get frozen in an ice cube in the back of the freezer so you don't use them anymore). Then, look at that student loan debt. I recently refinanced my 6% student loans (using SoFi, but I hear common bond and others are similar) down to 3.6%. This freed up a few hundred bucks in my budget, but you lose any forebearance/grace periods federal loans give you. It lowered my monthly payments by a few hundred dollars a month.

I wouldn't put any of your 29k toward the principle of the student loans, but between a refi on the student loans and a payoff of the credit cards, you'll be a few hundred bucks a month richer, which you can dump in the 401k and get a match on!
posted by slateyness at 11:30 AM on August 8, 2015 [2 favorites]

An observation that I believe is not addressed above: is there anything you can do with money that will increase your earning potential? Is there a course or certification or experience you could take on that might make sense to do with money? Something to consider while you're living paycheck to paycheck.
posted by vunder at 12:09 PM on August 8, 2015 [2 favorites]

Also (I am not your accountant but) do not ignore the tax implications of the windfall. It's going to suck if you discover that you owe 25% or so after you have spent/allocated it all. This speaks to investing a good portion in a retirement savings that reduces your tax liability. If you're unclear about what this means, the very first thing is to get totally clear on this. Paying $7-8k in taxes on that money is going to make the decision about the $500 a year in interest on the $3k credit card seem less significant.

My instinct says the simplest tax protection is going to be a lump sum contribution to the 401k this year to the limit. I believe this is $18k this year, which would protect you from something like $4500 in taxes this year.
posted by vunder at 12:26 PM on August 8, 2015 [4 favorites]

do not ignore the tax implications of the windfall

I inherited a similar amount a few years ago, and despite contributing several thousand extra to my payroll-deduction 401(K), I owed over $5,000 in federal tax when I filed the following year. I actually had to ask a relative for a short-term loan to pay the IRS (luckily, I can get overtime at time+1/2 on my job, and settled my debt with the relative by year's end). This amount of inheritance is added to your regular income for tax purposes (Schedule K, I think?), putting you in a definitely higher tax bracket for the year in which you inherit. Be sure to leave some money liquid for this, and don't think of it as "yours" until your taxes are settled next April.
posted by RRgal at 1:52 PM on August 8, 2015 [1 favorite]

I would contact a tax consultant now. My understanding is you can prepay estimated taxes in situations where you suddenly have an income spike so as to try to avoid ending up in a pickle over it.

Then plan what to do with the rest after the taxes are paid.
posted by Michele in California at 1:58 PM on August 8, 2015

I just scanned the above, but I think there is a piece of advice missing here.

If you pay off a credit card, or credit cards, or pay off of pay down you school loan, you have more disposable income to the tune of all of the payments you've just eliminated or lowered. Personally, I would put this amount into building an emergency fund, and then switch to the IRA to get the matching.
posted by DarlingBri at 1:36 PM on August 9, 2015

Do you have renter's insurance?
posted by oceano at 7:33 AM on August 10, 2015

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